Is The Fed Trying To Create A "Bond Run" Panic? Yes... In Its Own Words

One of the most significant, if underrpeported stories of the week, was the announcement from Monday that in order to "prevent" bank runs, the Fed is preparing to impose "exit fee" gates on bond funds, in what, the official narrative goes, is an attempt to prevent a panicked rush for the exits. Of course, this is diametrically opposite of what the truth is.

This is what wesaid: "it goes without saying that "discouraging investors" from withdrawing funds is the last thing on the Fed's mind, which knows very well that when it comes to investor behavior all that matters is how the Fed's future intentions are discounted. And with this unprecedented step, the Fed is sending a very clear message: it may be next year, or next month, or next week, but quite soon you, dear retail bond-fund investor, will be gated and will be unable to pull your money.... what is the obvious desired outcome, at least by the Fed? Why a wholesale panic withdrawal from bond funds now, while the gates are still open, and since those trillions in bond funds have to be allocated somewhere, where will they go but... stock funds."

But wait, this would mean that instead of attempting to prevent a rush for the exits, the Fed is in fact doing the opposite, and is seeking to force investors to sell those sticky bonds they are holding on to and destroying the propaganda of a recovery (remember: you can't pitch a stable inflation-driven recovery fable when the 10Y is trading at 2.50% in the process launching the very run for the exits it is supposedly trying to avoid.

Pure conspiracy theory right?

Well, maybe. But that doesn't explain why someone else who agrees with our assessment is none other than... the Fed?

Our paper is the first to show that the possibility of suspending convertibility, including the imposition of gates or fees for redemptions, can create runs that would not otherwise occur. This contrasts with the existing literature, which focuses on whether suspension of convertibility can prevent runs. In other words, we show that rather than being part of the solution, redemption fees and gates can be part of the problem.

more:

... we show that there can be preemptive runs that occur only because an intermediary has the ability to impose "standby" (liquidity-contingent) gates or fees. Second, we show that for an intermediary that maximizes the expected utility of its own investors, imposing a gate or fee can be ex-post optimal. Hence, for an intermediary that can restrict redemptions in a crisis, a policy of not imposing such restrictions may be time-inconsistent. The financial intermediary might like to commit not to restrict redemptions, so that preemptive runs would not occur. Absent a means of ensuring commitment, however, the intermediary will find it optimal to suspend, confirming the beliefs of informed investors who withdrew preemptively.

Stated far more simply: the mere prospect of gating creates a self-fulfilling prophecy that results in the very bank run the gate was designed to prevent.

One can be sure that the same Fed, which is proposing "exit fee" gates is quite aware of this paper's conclusions. In fact, one can be certain that the Fed is imposing said gates precisely due to the findings of this paper.

In other words, the Federal Reserve, tasked with preserving financial stability, because not even the Fed pretends to be in the inflation and unemployment dual-mandate business any more - it is all about the "not a bubble" valuation of the S&P 500 - is actively seeking to create a bond run panic!

We wonder just which part of the Fed's "financial stability mandate" covers the Fed's attempts to spark a bond sell off.

Ironically, subversive intentions aside, as usually happens with the Fed when the intended theoretical outcome comes crashing down in the real world, an attempt to created a "controlled" panic, limited solely to bonds may very well backfire and result in a paniced withdrawal of other asset classes, including the most precious one of all to the Fed - equities.

Our results have broader policy signicance. Rules that provide intermediaries, such as MMFs, the ability to restrict redemptions when liquidity falls short may threaten financial stability by setting up the possibility of preemptive runs. Much of the wider policy signicance of that risk is beyond the scope of this paper, since our model does not incorporate the large negative externalities associated with runs on financial institutions, including MMFs. But one notable concern, given the similarity of MMF portfolios, is that a preemptive run on one fund might cause investors in other funds to reassess whether risks in their funds are indeed vanishingly small.

Example of the above: the S&P downgrade of the US which was supposed to drive investors out of bonds (and into stocks), had precisely the opposite effect.

But more importantly, now that the Fed has explicitly said in no uncertain terms that gating bonds funds will likely result in a loss of "financial stability", the next time there is a mandated market crash originating from either a bond run, or wholesale liquidity extraction panic, the world will know just who the guilty party is: the Fed.

This would be similar to something like Florida State leading Alabama in a national Championship game and the refs changing the rules at their whim to give Bama a victory. (I love Bama, so don't take this as a slam - just using two great teams as an expample). This is as bad as changing the definition of default last year when the Greeks defaulted and no one wanted to pay out on CDS and start the implosion.

You know the shit is fucked up when they do unnatural shit to prop something up and then change the rules to keep it going. Yay! The goverment always speaks the truth, don't they? And Central Planners always fix things, don't they? I guess neither of them has heard about or understand the laws of nature...

This fed proposal for lock ups and exit fees for bond funds has the sole purpose of making sure that the U.S. dual citizen oligarchs get out of bond funds now while they still can. The NY Fed's piece is just reinforcement of the message, namely that the Fed is ready to take bonds lower in price, higher in yield.

I agree, they are preparing for the eventual interest rate increase. Once rates go up which they have to eventually to normalize the system, bonds are going to get annihilated. Being an optimist (gets harder every day), I think they want to avoid everyone from getting destroyed in bonds when they do increase rates. However, they can't get people out of the way of the cement roller, austin powers style, people just wont move. So they want bond investors to move out of the way or be more likely to wait out a crash in bonds. All the while, stocks will go down when interest rates are raised, but they go down less because some bond money is now in the stock market to cushion the blow by adding liquidity. I think that's the attempt at least by the fed and if that were their intention, then it does at least try to meet their financial stability job.

They are just trying to undo what fuk face bernanke did when he doubled quantitative easing to 85 billion. He went rogue and his ego got in the way of rational thinking, because QE wasn't working and he wanted to go all in, it works or he dies trying mentality. Deep down that asshole knows you stimulate hard at the beginning of a crisis then let off the gas, you don't do it 4 years out.

Perhaps, perhaps not, but if it does, the sheep will likely turn on the closest representatives of the bankers first. While I wouldn't lose any sleep over the nearest BofA, WF, big megabank branch being burned down, I suspect that angry sheep might try to make sure that the tellers and branch managers are inside when it burns. These are people who, while part of a corrupt system, likely don't even comprehend that they are part of a corrupt system.

Predators (smart, strong, fast, dilligent, cunning and organized) beat and eat the prey (dumb, weak, slow, lazy, naive and disorganized). Even if outnumbered. I feel sorry for you (but not too much), if the Bible or mamby-pamby Sunday School didn't teach you the real facts of life, or Mother Nature's laws. Which have been true for the last Billion years.

I think the real takeaway here is whether ZHers have learned anything to front-run the Fed. And I don't mean the way many got burned by buying PM on the way up, during QE front-running (Summer-Fall 2012).

The question is: (a) is ZH right about the Feds' motives and intent, and (b) if we do try to front-run the Fed again, will we be safer this time?

This is not the time to bitch & moan like an under-tipped whore. It's time to stand up and be counted, I'd say.

If they're trying cause one, they will announce with a bullhorn that they're considering closing and locking the gates, just not yet. But "oooh!" are they seriously considering it. MSM yackity-yack heads will debate the possible effects of shutting the gates ... papers are issued debating this or that aspect of closing the gates. They may even actually, at some point, lock the gates after the horses are gone.

If they're trying to prevent a run, you wake up one morning to find the gates locked. No warning, no MSM yackity-yack.